Benjamin Graham’s Clever Idea for Averting Currency Wars

By Joe Carlen -
Feb 28, 2013

Benjamin Graham is remembered
primarily as the father of value investing, and as the former
professor, employer, friend and investing mentor of Warren Buffett. Yet Graham did a lot more than dispense sound
investment advice.

For one thing, he developed a subtle and clever idea for
stabilizing currencies -- and economies -- that might bear
closer examination today. He called it the commodity reserve
currency.

Graham first formulated the idea in response to the
recession of 1920-1921. During that crisis, Graham observed that
the price of gold was remarkably stable while the prices of many
other items, even basic commodities with far greater direct
impact on the economy than precious metals, were dropping
precipitously. From his perch on Wall Street, Graham saw these
declining prices reflected in plummeting corporate earnings.

At the time, each U.S. dollar represented a fixed amount of
gold. Graham noticed how that dynamic stabilized the price of
gold (and, to a lesser extent, silver) while the price of other
goods crashed. Gold producers were “exempt from the difficulties
that bedeviled the rest of us,” he wrote.

So, with characteristic inventiveness, Graham wondered how
much more stable the economy would be if, instead of precious
metals alone, fixed quantities of more essential commodities
would be pegged to the value of the dollar. He speculated that
this would ensure that the prices of, say, petroleum or wheat
would be as stable as that of gold.

Commodity Unit

Graham never published his macroeconomic prescriptions
during that recession, and during the subsequent boom years of
the 1920s they no longer seemed relevant. It was not until the
onset of the Great Depression, and an ever-widening discrepancy
between gold’s price stability and that of basic commodities,
that his interest in this area was rekindled. He began to set
his old idea to paper.

The plan he advanced in the 1930s revolved around a
“commodity-unit” currency. At the time, the dollar represented
23 grams of gold. Graham proposed that his new form of currency
represent a basket of 23 commonly used commodities: “23 small
quantities of different basic raw materials,” as he put it,
“tangible, basic goods that we use and need, in their proper
relative amounts.”

He thought this plan would help stabilize the prices of
basic foodstuffs, textiles, nonprecious metals and other vital
elements of production and consumption, such as rubber, which
had all suffered significant declines in price during the
Depression. The increased stability, he argued, would ripple
throughout the economy, leading to steadier pricing, production,
consumption, corporate earnings and employment.

Graham further proposed that to help counter the lower
demand for these vital economic inputs in periods of slow
growth, the government could purchase a reserve of the 23
commodities from their suppliers and store them. Then, when the
economic cycle turned, these reserves would be sold in exchange
for money. During the lean years, the reserves could also serve
as an emergency supply of basic goods.

Regarding his plan’s effect on price stability and, by
extension, economic stability, Graham wrote that “the general
price level for basic raw materials in the open market would be
held close to the standard level by the most direct method
possible,” meaning the purchase of these commodities by the
government “in the open market whenever the price level tended
to decline, and their sale in the open market whenever it tended
to advance above the standard level.”

Currency Wars

Graham first published these ideas in the Spring 1933 issue
of the Economic Forum, with the title “Stabilized Reflation,”
which would later become the basis of “Storage and Stability.”
In “World Commodities and World Currencies,” published in 1944,
he expanded the concept to an international system that would
help prevent the currency wars and protectionism that played a
role in instigating World War II.

To that end, Graham made some significant modifications to
his domestic plan -- most notably, a smaller basket of 15
commodities and active buying and selling by a sub-agency of the
International Monetary Fund, instead of the U.S. government.

The Nobel Prize-winning economist Friedrich Hayek wrote a
lengthy article endorsing Graham’s commodity reserve currency,
and John Maynard Keynes wrote to Graham expressing agreement
with an important aspect of the plan: “On the use of buffer
stocks as a means of stabilizing short-term commodity prices,
you and I are ardent crusaders on the same side.”

Although Graham’s plan faded into obscurity during the
latter half of the 20th century, it has since resurfaced in some
notable places.

In his 2002 book “The Money Changers: Currency Reform from
Aristotle to E-Cash,” the British economist David Boyle praised
“World Commodities and World Currencies” and wrote that
“Floating currencies -- as we have them now -- are thoroughly
dangerous,” as Graham warned, “because they are not based on
anything.” In 2011, John W. Allen, an international-trade
specialist who once worked with World Bank President James Wolfensohn, praised the commodity-reserve-currency plan and
described Graham as one of “history’s most eminent economists.”